Investors Are Descending Into The Five Circles Of Bond Hell

Bond investors are struggling to find a decent yield in this
environment of low interest rates.

U.S. 10-year Treasury notes currently yield about 2.5%, just
slightly better than the just-less-than 2% inflation we've seen
over the first half of this year.

As a result, bond investors are left with only bad — or at least,
suboptimal — options right now.

Peter Tchir at Brean Capital published a research note on what he
calls "The Circles of Bond Hell."

There are five:

1. Hope Market Cheapens: Some folks are just
waiting for bond prices to fall and yields to rise. But if your
investment strategy has come down to "Hope the Market Cheapens,"
you have no investment strategy. You are going to church. Tchir:
"While this strategy has the appeal of being risk averse, it
hasn't worked at all."

2. Increase Duration: If you are forced to
increase your duration, you're exposing yourself to interest rate
risk. And in (overly) simple terms: When short-term rates rise,
the stuff you own that doesn't mature for a really long time is
worth less. Tchir: "This seems to be fraught with career risk at
this stage." This sounds appealing.

3. Decrease Credit Quality: This forces
investors to take a step down. So an investment-grade investor
buys high-yield corporate bonds, which carry more default risk
but yield more, and a government-bond investor buys
investment-grade corporate bonds, and so on.
Tchir: "While dangerous, this remains a viable way to
increase yield — assuming the central banks continue to support
the markets and the economy muddles along."

4. Give up Liquidity: Basically, you gotta buy
stuff that's harder to get rid of in order to get returns. This
is scary because you can't get rid of things when the market
turns against you. Tchir: "It does mean that your credit
decisions have to be better than otherwise, because you likely
own this in a down market."

5. Increase Structure: Buy more complicated
stuff. Buying an asset-backed security, which might include some
auto loans, mortgages, and other things, instead of buying a
high-yield corporate bond from one company. But the more stuff
you've got, the less you know about how to use it, basically.
Tchir: "This is the next most logical step ... This is where the
value is and where investors will be forced to move as it is the
best option left to increase yield."